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11/15/2009

Will We Go the Way of Japan? No, Unless US Government Policies Discourage Growth-Becker

Japan has had a very slow rate of growth in its GDP since 1991, averaging just a little over 1 percent. Given this slow growth, and the government's continued failed efforts to prop up their economy by running large fiscal deficits, the ratio of government debt to its GDP has risen from only about 50% in 1995 to by far the highest ratio in the developed world, at about 170% in 2008. Estimates indicate that it could rise to over 200% by next year as the budget continues to spill red ink, and may grow even much further during the next decade. Such a large debt ratio has been manageable so far only because interest rates have been very low, at about a little over 1%. But these rates have recently been rising as concern is growing about the fiscal solvency of the Japanese government.
The danger of any explicit default on this debt is minimal since it is all denominated in the Japanese currency, the yen. Any country can reduce the real value of a debt burden in its own currency by printing money to finance a good chunk of its government spending, and thereby create inflation that destroys part of the real burden of the debt. I do not expect that to happen in Japan unless the debt burden becomes intolerable down the road.
All this is background for comparisons between Japan and the US. As Posner indicates, the American ratio of debt to GDP is now about 50%, where Japan was in 1995. It is also rising rapidly as the government continues to increase its spending on banks, the stimulus package, likely also on health care, maybe subsidizing employment of the unemployed, subsidizing mortgages, and in many other ways. The ratio of federal government spending to American GDP was quite stable at about 20% for about 40 decades, but this ratio has been rising rapidly during the past year, and it is beginning to approach 30%. The government debt is not yet a great burden because, as in Japan, interest rates are low, so that annual interest payments on the debt is not a sizable fraction of total government spending.
It is unlikely that US government spending will decline during the next decade, even though some of the short term spending on banks and stimulating the economy will probably fall sharply. Any spending declines from these directions will be more than replaced by much greater spending on Medicare, Medicaid, and other government financed health programs, on social security, and on various other entitlement programs. The direct impact on the debt burden of such budget deficits can be reduced only by higher taxes or inflation. Eventually, I do expect much greater inflation in the US. The Obama administration has also been vocal about its plan to raise taxes, especially on higher income persons, as soon as the recession is clearly over and the economy is growing again. That would be a serious mistake.
The best solution to reducing the real burden of the public debt is neither inflation nor higher taxes, but more rapid growth of the American economy. This involves lower, not higher, taxes on investments and incomes of small and large businesses. It also requires greater concern about the fact that the US is falling behind many other countries in the proportion of its young population, especially males, who receive a higher education. In addition, much greater attention needs to be paid to correcting the depressing statistic that the fraction of boys who drop out of high school has been stuck at about 25% for several decades, even though the economic and other benefits of finishing high school and going to college have risen dramatically. To its credit, the Obama administration has given high priority to improving the K-12 performance of American students, especially those from minority backgrounds.
In effect, the desirable policies to stimulate growth involve a retreat from the anti-business rhetoric that pervades Congressional Democrats and some of the top players in the executive offices, and a more pro-consumer and pro-business mentality. It is necessary to maintain the minimalist anti-trust policy that developed during the 1980s and 1990s under Democratic as well as Republican administrations, to retreat from the policy that banks and other businesses, such as GM, cannot be allowed to fail when they are mismanaged.
Desirable policies also include the elimination of efforts to restore union power in the private sector, and resistance to the desires of some members of Congress to have the US retreat from a free trade policy> They also want to impose onerous regulations on businesses of all kinds, especially the more successful ones. I am perhaps particularly disturbed by the anti-immigration rhetoric of leading members of Congress since immigrants have contributed so much to the dynamism of the American economy and society.
Sizable advances in productivity and the resulting sharp economic growth can ease the burden of growing government spending, and prevent anything like the expanding debt to GDP ratio and stagnation of the Japanese economy. Can the US do it? Certainly! Will the US do it? Not with the present composition of Congress, and with the tendency of the President to allow some of the more destructive members of his political party to get their way.

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